Credit Markets Update: Telco spreads balloon following WorldCom fraud

The admission by US telco WorldCom of a multi-billion dollar accounting fraud late yesterday sent credit protection spreads ballooning as much as 100 basis points today in both the US and Europe. But markets settled down as the day progressed, traders said.

WorldCom’s audit committee uncovered the scandal, the latest in a series of bad news for WorldCom, which now calls into question the telco's long-term viability. It has been virtually impossible to buy credit protection on WorldCom debt since April, traders said.

But a contagion effect caused the five-year credit default swap spreads on US telcos AT&T and Sprint to widen about 100bp this morning, trading at 710/760bp and 650/700bp respectively.

“The markets really reeled when they opened this morning,” said a US-based credit derivatives trader. Spreads widened across all sectors – up 10-15bp for active names in autos, telecoms and financials. But heavy volumes were not traded. “We don’t see heavy volumes going through in this sort of panic, the prices are out of reach,” said John Piluso, a trader at GFInet in New York.

“After an hour things settled down a bit,” said a third US trader. “Spreads have come in a bit and are now probably about 5-10bp up on yesterday.”

In Europe, the WorldCom news also caused spreads to widen across the board. According to one London-based trader, telecoms were most heavily affected – especially the most volatile names. Alcatel and Ericsson both moved out 200bp to 850/950bp and 850/1100bp respectively with no real offers. Both curves were heavily inverted but short-term protection was not being offered by the market, traders said.

France Telecom also moved out about 80bp, with five-year protection trading at 680/740bp, and three-year at 750/850bp. Autos and utilities also widened 3-7bp. Financials widened 1-3bp on senior debt, but tightened in again as the day progressed.

By late afternoon in London traders said the market was calming and spreads tightening as the US market slowed its rate of widening. “There is a lot of demand and strong bids, but at the same time few offers are being lifted,” said Luca Favero, a corporate credit derivatives trader at CSFB in London. “But now investors are scared and they are waiting to see how the market reacts, which is slowing the pressure on spreads,” he added.

Credit protection on WorldCom has not been available since late April, when the company released a grim financial forecast, which was swiftly followed by the resignation of chief executive Bernard Ebbers. Bids for five-year credit default swaps on WorldCom rocketed to 2,000bp. Previous to the news, credit protection traded at 400-500bp-mid. Since April, WorldCom has been under investigation by the Securities and Exchange Commission (SEC) in the US over accounting irregularities.